Yen's Downward Spiral Threatens Global Financial Stability

The yen's depreciation has become a global concern, prompting intervention from Japan and the US. While Japan's substantial foreign exchange reserves provide capacity for intervention, persistent weakness could trigger broader market spillovers through three channels: immediate impact on US Treasury markets, structural effects via the yen-funded carry trade, and changes in Japanese institutional investors' asset allocation.

Japan is a significant holder of US Treasuries, with over $1.14 trillion, or 12% of total US treasuries as of May 2026. This makes intervention particularly important for global fixed-income markets. If intervention involves selling dollar assets and purchasing yen, it could increase Treasury supply, putting upward pressure on US yields.

US Treasury yields are already under upward pressure from fiscal deficits, large issuance requirements, and inflation risks. Higher yields have direct implications for the US government's debt servicing burden. The potential increase in US Treasury yields also has broader implications for global financial conditions, as yields serve as a benchmark for pricing sovereign and corporate debt worldwide.

Japan has an alternative to outright liquidation of its foreign assets through the Federal Reserve's Foreign and International Monetary Authorities (FIMA) Repo Facility, which allows foreign official institutions to obtain dollar liquidity against their holdings of US Treasuries without having to sell them immediately. However, this can only provide temporary relief and does not address the underlying cause of yen weakness.